T N Ninan: What about depositors?

It is curious that discussion on the rates that banks offer customers focuses primarily on lending rates. Almost no one looks at deposit rates, although it is obvious that if no money comes in as deposits, nothing can be lent out. The general drift of opinion today is that the Reserve Bank should be nudging lending rates down. The usual corollary to that would be lower deposit rates, or banks would not be able to maintain what is called their net interest margin. From this perspective, it is worth noting that bank deposits have been growing ever more slowly; the growth rate dropped from 18.3 per cent in 2009-10 to 16.7 per cent in 2010-11, and down further to 13.8 per cent in 2011-12. Deposit growth this year has been at the same slow rate as last year. So, could it be that sustained high inflation of 8-10 per cent has made the interest rates on fixed deposits (8.5-9.0 per cent) seem unattractive? After all, the “real” (ie inflation-adjusted) rates on fixed deposits are seen as being close to zero.

Why should customers keep their money with banks when they expect no real return, if they have an option? Indeed, customers do seem to be looking for options, or the growth of deposits would not have slackened.

How has bank credit done, in the period when deposit growth has been slower? Credit growth accelerated from 16.2 per cent in 2009-10 to 23.3 per cent in 2010-11 before slipping back last year to 16.3 per cent. In the last two of these years, the credit growth rate outpaced that of deposits; as should be obvious, this cannot go on indefinitely. And here’s the thing; nearly 40 per cent of the lower credit growth over the past year has been financed by a drop in banks’ investment in government securities; so a good bit of the money that has been lent has not come from customer deposits. Banks could continue to pull money out of government securities, but if they did that the government would not be able to finance its deficit. In short, if credit is to grow at a rate that is sufficient to keep the wheels of an expanding economy moving, deposit growth has to be maintained and improved. How can that be done if deposit rates are lowered, despite a stubbornly high rate of inflation?

In other words, it is time the deposit side of the equation got some attention when debating whether to drop lending rates.

This is of course presenting the issue in its simplest form. In the real world, one has to factor in other issues, like gold — which has seen a surge in demand, even at much higher prices, and could explain some of the diversion of money from bank deposits. Still, it is undeniable that the commercial sector is not getting much additional money from the banking system. The total flow of funds, in the form of credit, subscription to bond and share issues, and commercial paper, has grown by just 5.5 per cent so far this financial year — down from 6.2 per cent in the same period of the last financial year, and 9.5 per cent the year before. It is inconceivable how fund flow from banks to companies can be stepped up without deposit growth being sustained and improved. That argues against dropping rates. One way to square the circle is to bring down inflation, so that the existing deposit rates look more attractive. The other is to have the government borrow less from banks (ie reduce the fiscal deficit).